Investment Portfolio Allocation

There are various avenues of investment. But how do we decide how much of each asset should be acquired? In this article we take a look at Asset allocation and how to structure an investment portfolio. There is no hard and fast rule but to start with it would be a good idea to write down all your investments in an excel sheet and see how they are distributed and what your exposure to each asset class is. The article is specific for Indian investors though most of the ideas expressed are universal.

Importance of Portfolio Allocation

An investment portfolio can consist of different asset classes like equity, debt, Fixed Deposits, Government saving schemes [like EPF, PPF or Post Office], precious metals, commodities, insurance linked saving products or real estate. You can also get exposure to most of these asset classes through Mutual Funds as well. Within each asset class you have many choices, for example, within equity you can invest in large cap or mid cap or small cap stocks. There are also more exotic asset classes like Art, collectibles [Stamps, coins, comics] etc. So maybe a future asset class would be old generation electronic gadgets! 50 years down the line the first generation iPod may be a collector’s item selling for a few million dollars!!

It is essential that you are aware of your asset allocation in order to improve your overall return. If your investment is skewed towards low return products or riskier products you may end up as a loser. Asset allocation helps you to be systematic in your approach to investment. It also allows you to diversify your portfolio to reduce risks and improve returns. A smart investor does not put all his eggs in one basket. One needs to diversify between asset classes and within asset classes. The idea is to improve your returns while maintaining risks at lower levels. A tight rope walk which can be practiced and improved over time.

Risk and return are intricately linked. It is advisable to take calculated risks but there is a thin line that separates it from a rash decision. Riskier assets can give superior returns over time but sometimes in our quest to get rich fast we acquire a riskier asset for short term gains and end up getting burned.

Portfolio Allocation – What are the choices?

How to allocate your investment portfolio is a matter of personal choice. The goal is to strike a balance, reduce risks and improve returns using a mix of investment avenues available to us.

It would be a good idea to invest 10-15% of your savings in equity. If you have more tolerance for risk then you can surely increase it up to 35%. This can be done directly or through mutual funds. It would be prudent to lock up about 20-35% of your savings in FDs with at least 10% in high yielding FDs [9-10%] of long tenures of 8-10 years in a public sector bank. You could look at high yielding FDs of companies with good credit rating as well. Balanced Mutual funds invest in both equities and debt instruments and give good returns with lower risks. One could invest about 10% of one’s total savings in these. Both Public provident fund [PPF] and Post Office combo of MIS [Monthly Income Scheme] +RD [Recurring Deposit] give good post tax returns. I would recommend that you invest as much as possible in these. Long term bonds with high interest yield like the recent issues of SBI are a good option as well. You could allocate about 10 % for high yielding debt instruments. Avoid insurance related saving products. You could also get exposure to debt through mutual funds. Investors with more risk appetite can also diversify into precious metals like silver or gold with about 10-15% exposure. It is better to buy gold and silver coins/bars from National Spot Exchange or Bangalore Refineries than from banks.

Types of Investors

Aggressive Investors – They have high risk tolerance and invest in high return, high risk assets like Equity, Commodities, etc

Defensive investors – These kind of investors are risk averse. Basic aim is to preserve capital.They invest in low risk low return assets like government securities,bank deposits etc.

Under-informed investors – Some investors invest in high risk low return products. They are usually victims of get rich quick scheme or an unscrupulous wealth advisor who is selling a sponsored product like insurance linked saving products. They usually do not think through their investments and invest in high risk low return products.

Smart investor– Ideal but extremely difficult to achieve unless you are Warren Buffet. The aim is to take baby steps by rebalancing, by booking profits in winners or fishing for assets when they correct substantially. A smart investor gets superior returns with a mix of instruments so that overall risk is moderate.

Target Portfolio – Choose a mix of assets [as explained in article under ‘what are the choices?’] so that you have a return of about 10-13 %. Review and rebalance your portfolio as explained in the article to slowly improve your overall return with the objective of becoming a Smart Investor

Time Horizon is an important part of the saving strategy. We save for a variety of reasons and for each one we can use a different investment option. Choosing a wrong option can leave you with a lot less than what you need. Equity, Commodities and precious metal are better for long term requirements. A quick example is given below.

1. Annual Vacation – Recurring Deposit[RD]; FDs[Short term]; FMP of Mutual fund

2. Child’s Education/Marriage – Recurring Deposit[RD]; PPF; PO MIS+RD combo; SIP in Mutual funds; Stocks, Precious metals

3. Retirement – PPF, NPS, SIP in Mutual Fund, Precious metal; Stocks, Real Estate

4. Short Term goals [ < 9M] – FDs[Short Term], Mutual funds[Liquid schemes]

FMP – Fixed Maturity Plans; PO -Post Office Monthly Income Scheme; SIP – Systematic Invest Plan; NPS- National Pension Scheme

Rebalancing or realigning your Portfolio

At your workplace you have reviews for everything – Quarterly, Annual, Monthly, Daily or even hourly. But do you review your investment portfolio? It is a good idea to do it half yearly or at least yearly. Interest cycles turn, Stock markets yo-yo, Tax policies change, Bubbles burst. All these are opportunities for getting your portfolio into ship shape. It is important that you reallocate in the right direction. Rebalancing is not allocating money in haste at the top of a bull run just because you heard a stock tip or when silver or gold has just climbed its highest and it is front page news. Rebalancing is about shifting to stocks in a sustained downturn or increasing allocation to long term fixed income securities when interest rates are reaching the peak or catching some assets while they are correcting. Rebalancing also has another aspect to it. When one or more assets peak in price your portfolio allocation gets skewed and you may have to sell those assets to bring back your asset allocation to the original level. So you bring about discipline to selling and avoid the usual “I will hold on, this will surely make me a millionaire” approach to certain assets which most often than not just causes heartburn when they go back to the price you bought them for. It is always wise to move money slowly out of winners and invest in lagging but fundamentally sound asset classes. A systematic approach to rebalance brings you closer to the much flogged term in investing “buy low sell high”. Rebalancing requires patience and thought.

The message I want to convey is that asset allocation bring about discipline and clarity to your investments. Reviewing and rebalancing your portfolio improves overall returns in the long run thereby allowing you to squeeze more out of your investments.

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